A bond is a three-way party agreement between the Surety, the Principal (who is the contractor or applicant) and the Obligee. The Surety is the party positioned behind the performance of the Principal. The Surety has evaluated the Principal’s ability and willingness to perform and is providing their stamp of approval with a bond. If the Principal is unable to satisfy the terms of their agreement, the Surety assumes the responsibility and reimburses the Obligee.
Obligee is a formal word for a beneficiary who might be the project owner, government agency, etc.
Bonds are considered a specialty form of insurance, and the Surety is usually an insurance company. Surety bonds are very different than insurance, however, because the beneficiary is a third party. As long as the Principal does what is promised, the Surety will not be called upon to perform or pay. The Principal is the primary responsible party under the bond and is obligated to reimburse the Surety for any claims or expenses incurred by the surety if the Principal has not lived up to their agreement.
The Obligee is the beneficiary under a surety bond. If the Principal cannot or will not perform, the Surety steps in and makes good on the Principal’s obligation. The Obligee also has an obligation under the bond. If the Obligee fails to fulfill their responsibilities under the contract or agreement, neither the Principal nor Surety has any liability.
Bonds can be required either by law or contract. Bonds can be divided into the following broad categories: Contract, Commercial, Court, Fidelity, License & Permit, Federal, Public Official, and Miscellaneous.
Depending on the amount and the type of bond requested, surety underwriters may evaluate financial information, detailed credit history of the business and its principal owners, as well as management’s experience. Based on the Surety’s expert decision making ability, they will not only be able to assess a Principal’s ability to pay or perform an agreement, but the Surety will also be able to determine the Principal’s willingness to fulfill their promise.
The indemnity agreement is a legal document that fully discloses the Principal’s obligations in a surety relationship and provides for the Surety to recover any losses paid out on behalf of a Principal. The Principal is the primary responsible party under the bond and to reimburse the Surety for any claims or expenses they incurred if the Principal has not lived up to their agreement.
Surety companies give paper Power of Attorney to their appointed independent insurance agents to allow the agent to act on the behalf of the Surety to bind coverage for them.
The Surety’s claim department will conduct an investigation as quickly as possible to avoid any further damages and mitigate their exposure. It is important to note that, as the Principal under a bond, a pending claim does not necessarily mean there will be a financial loss incurred since the dispute may not even be legitimate. If the Surety does determine through their examination that the claim is valid, the Principal will be reminded of their obligations under the indemnity agreement and given the opportunity to satisfy the claim first. If the Principal fails to respond, the Surety will arrange settlement with the Obligee and implement collection proceedings against the Principal.